Deck 28: The International Monetary System: Past, Present, and Future

Question 1

What were the key elements of the international monetary system devised at Bretton Woods?

Answer 1

International monetary system is required and applicable for the countries those are open to the international market for trade, investment or any other purpose. It provides provision of payments that are acceptable to buyers and sellers of different nationality. If ability of a country to import is limited for scarcity of foreign exchange, they will be tempted to impose tariff, quota and other trade restrictions to restore their foreign exchange.
Key characteristics of international monetary system : - For taking part in an effective movement or trade it requires an efficient balance of payment adjustment. BOP is the record or transactions happened between home and foreign country. The adjustments imply that the deficits and surplus in trade payments are meet and adjusted properly. Thus the system must be characterized by flexible exchange rates. However along with that two more important characteristics must be there: -
(i) Supply of international liquidity (currency) must be adequate. It implies the system must provide enough reserves to meet BOP deficits or surplus.
(ii) Internationally acceptable reserve asset must be included in supply of international liquidity.

Question 2

How would you describe the current international monetary system in terms of the nature of the exchange rate arrangements?

Answer 2

In monetary system has a great dealing with the exchange rate and the system followed for that. Initially the system followed gold standard thus a fixed exchange rate regime. Post World War 1 the system became questionable due to increasing BOP deficits. After words the system changed to flexible exchange rate when it started operating under Bretton Woods's system. Post World War 2 during crisis, Bretton Woods's system came out to be destructive, however it had some good results though. But in post war period the deficit increased and the system lead to break down. Then the system started following managed float exchange rate and is still following it.
Since Bretton Woods broke down, countries applied carious exchange rate arrangements which were often termed as "non-system". Obviously it is to be noted that the arrangements were chosen by the members of IMF. A brief summary of those arrangements are as follows -
In the first category there was complete absence of flexibility in exchange rate. However it didn't have any separate legal tender. 13 countries were using this arrangement.
The second category termed as currency board arrangement also had no ability to change exchange rate. Under this rate country's currency value increase, reserves increases and as a result deficit in BOP is dissolved. 12 countries permitted this category.
Under category 2 to 7, minimal variation in exchange rate was allowed but it varies around a specific parity value. Hence as a result currency values increased as per reserves and comparative to other currency.
Category 1 to 7 comprises 69 countries who were member of IMF. Under this, the exchange rate is fully floating. Under this category, trade of the countries got improvised.
Under category 8 to 10, countries adopted a crawling peg system. Under this, the exchange rate varied very slightly according to need and thus the growth of the adopting countries.
Under category 11 and 12, combine effect occurred. They combined made up 35% of exchange rates. Mainly it followed floating and free floating that carried out according to need.
However it is very much clear that if country permits, flexibility in exchange rate can be adopted. An exchange rate that is resulting good for one country cannot result good for the other. The best policy is to be4 selected by authority of that country.
Currently, managed float exchange rate is being adopted by the countries, mainly the industrialized countries. The experience regarding the system is very recent as the system is still evolving. Due to this system following things have occurred -
(i) Overshooting of exchange rates have taken place.
(ii) This exchange rate attracted resources to the needed sectors.
(iii) This system has helped to increase reserves.
(iv) The system has improved the business cycle of the countries.
(v) Due to the system trade became improvised. However BOP deficits were decreased.
On an average the system led to an overall increase in growth and development of the countries. As the system is still in hence more growth is yet to come.

Question 3

What obstacles might the G-20 face in implementing coordination of macro policy?

Answer 3

A macroeconomic policy is concerned about economic growth and development. It deals with fluctuations in GDP which directly affect growth. Both informal and formal macro-economic policy does the same. Hence to meet world financial crisis, it's very much necessary to have well-coordinated macro policy in part of those nation. This task is done by G-20, which is nothing but a group of 20 well developed countries earlier which was a group of 7 countries and named as G7.
Obstacles : - G-20 went to series of meetings and discussions in April 2009 and decided to take various steps in removal of disequilibrium in the economy. The steps were as follows:-
(i) Tripling the resources in IMF to $750 billion.
(ii) Increasing SDR issues to $250 billion.
(iii) Creating new lending of $100 billion by developing banks.
(iv) $250 billion finance to trade sector.
All together these steps created about $1.1 trillion funds to strengthen world economy and finance.
The strategies and steps were followed in past. But a new country doesn't show such consciousness in implementing the steps, the countries those are in G-20. However the recessionary situation, decrease in world output and decline in trade were the main obstacle in the way of implementing the macro policy. However the leaders discussed about the problem. They also expressed their confidence to the leaders of FMU about their readiness to seek monetary stability.

Question 4

What are the key characteristics of an effective international monetary system? Does the current system meet these requirements?

Question 5

What led to the breakdown of the Bretton Woods system?

Question 6

Why might countries with one main trading partner tend to opt for a fixed exchange rate with that partner rather than a flexible rate?

Question 7

How does a target zone system differ from a world central bank system?

Question 8

What were the main problems in the Bretton Woods system? Are such problems present in the current system?

Question 9

What are the convergence criteria for EMU? Why are they necessary?

Question 10

What are two of the more serious problems that have surfaced with the current system?

Question 11

Why do economists in general not like the extensive use of capital controls?

Question 12

Why are SDRs often referred to as "paper gold"? What role do they play in the current system?

Question 13

How might the Tobin tax reduce exchange rate volatility?

Question 14

What is the similarity, if any, between a gold standard and a world central bank? What is the difference?

Question 15

What were the original purposes of the IMF? Have they changed since Bretton Woods? What is the justification for IMF surveillance?

Question 16

Why might it be said that a target zone system contains both the best and the worst of flexible and fixed exchange rate systems?

Question 17

"A target zone system will work only if there is coordination of economic policies among country participants. On the other hand, if this effective coordination of monetary and fiscal policy exists among the members, there is no need for a target zone system!" What is the logic behind this statement?

Question 18

From the standpoint of any given EU member country, what are the potential advantages of joining the EMU? What are the potential disadvantages?